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Get Four
|  | NOVEMBER 11, 2004
 S&P RATINGS NEWS Big Pharma's Report Card These are anxious times for the drug giants, which are uncomfortably aware that the first outfit to restock its pipeline will surge ahead of the pack The third quarter of 2004 hasn't been kind to the major U.S.-based pharmaceutical companies. In a period in which several of the players are already struggling with a dearth of new product launches, declining sales of key products, and looming patent expirations, Merck's (MRK ) surprise market withdrawal of Vioxx , its COX-2 inhibitor pain medication, was the biggest blow. The withdrawal meant not only the vaporization of $2.5 billion in annual sales, but also the beginning of a long product-litigation nightmare for the company. Meanwhile, Bristol-Myers Squibb (BMY ) and Schering-Plough (SGP ) experienced slight sales declines, as weakness in their key franchises -- Bristol-Myers' in its cholesterol-lowering statin Pravachol and Schering-Plough's in its hepatitis C treatment PEG-Intron -- offset gains by younger products. Eli Lilly (LLY ) continued to suffer declines in U.S. sales of its antipsychotic drug Zyprexa. All four outfits experienced gross margin declines. And some companies, such as Bristol-Myers and Lilly, are shedding sales staff. Restructuring will be a consistent theme for the next several quarters as several of the major pharmaceutical companies pare R&D, manufacturing, and sales infrastructures to adapt to the harsher reality the industry is now facing. Even 'AAA'-rated Pfizer (PFE ) warned that results in 2005 will be affected by generic competition to four major products -- Diflucan, Neurontin, Accupril, and Zithromax -- which collectively accounted for $5 billion in annual sales. Not the best of times for Big Pharma. However, not all the news was bad. Lilly and Wyeth (WYE ) both posted double-digit sales increases in the third quarter because of continued strong sales growth of their key products. Merck and Schering-Plough jointly launched the high-sales-potential cholesterol-lowering treatment Vytorin, and Lilly launched its antidepressant Cymbalta. Furthermore, the passage of the American Jobs Creation Act provides pharmaceutical companies with a major opportunity. Major industry players haven't yet disclosed publicly any plans on repatriating funds from abroad. Where do the big drug outfits stand in the wake of these recent developments? Here are Standard & Poor's Ratings Services' views on the credit ratings and outlook for major U.S.-based pharmaceutical companies: Bristol-Myers Squibb (Rating: A-/CreditWatch: Negative) Despite strong sales growth of Plavix and Avapro, Bristol-Myers faced a 2% overall decline in U.S. third-quarter sales and essentially flat worldwide sales as its drugs Paraplatin and Glucophage came under fire from increased generic competition. Meanwhile, Pravachol fell prey to branded competition, its total sales dropping 24%, to $598 million, as it faced continued pressure from Pfizer's Lipitor, the market leader, and from a newly launched rival, Vytorin, from Merck and Schering-Plough. Pravachol doesn't lose patent protection until early 2006, but sales are expected to continue sliding, a decrease that may accelerate. Standard & Poor's expects Plavix and Avapro to continue generating strong growth in the intermediate term. Developments to watch: • Bristol-Myers is expected to file for U.S. Food & Drug Administration (FDA) approval on three drug prospects over the next year. • Patent litigation on Plavix is set to go to trial in early 2005. • Standard & Poor's will also watch the rate of decline in the sales of Pravachol. The bottom line: Management has made progress in resolving several of the company's issues, and has begun to shrink infrastructure. (It recently reduced its sales force by 500.) However, Bristol-Myers needs additional new products now. A gradual decline in Pravachol sales over the next year and a half, after which its patent expires, is incorporated in the ratings. However, an adverse litigation development on Plavix isn't. The loss of Plavix sales would likely result in a downgrade. The magnitude of such a downgrade depends a great deal on the success of newer products. Eli Lilly (Rating: AA/CreditWatch: Stable) Lilly's eight newer franchises, including the key products Cymbalta, Strattera, and Cialis, contributed 12% of total company sales, up from 6% last year. Standard & Poor's expects these newer drugs to continue to contribute a greater portion of Lilly's revenues and earnings. However, these new products are being counted on heavily to offset possible continued declines in some key franchises. Increasing competitive pressures in the U.S. have hurt the sales of two key franchises. Sales of Lilly's all-important Zyprexa dropped 9% in the third quarter on a 22% decline in the U.S. The domestic retreat followed wholesaler destocking, which possibly reflects less U.S. demand. Zyprexa fared better internationally, as sales grew 12%. Sales are expected to grow worldwide for the full year, but the recent declines are troubling. Evista sales also declined in the third quarter as a result of competition in the U.S. market. Competitive pressures also led to a slight decline in the diabetes franchise. In the meantime, Lilly announced a restructuring that will result in the elimination of nearly 1,000 positions, 575 of which are related to sales and marketing. The restructuring should be mostly completed by May 31, 2005, at an estimated cost of $320 million to $420 million. The charge will be taken in the fourth quarter of 2004. Developments to watch: • Cymbalta is the most important of the recent launches. Standard & Poor's will watch to see how sales of the drug ramp up. • Zyprexa's U.S. sales decline is troubling, as the drug generates nearly half of Lilly's earnings. • There has been no news on the ongoing Zyprexa patent trial, but Standard & Poor's is keeping an eye on it. The bottom line: The launch of Cymbalta was a key development for the company. There are no immediate concerns about the rating. However, in the longer term, the sales growth of newer products, such as Cymbalta, is critical if the company is to maintain its business profile. Merck (Rating: AAA/CreditWatch: Negative) Merck has had an eventful third quarter, to say the least. The surprise withdrawal of its COX-2 inhibitor Vioxx eliminated $2.5 billion in annual sales of a franchise that scored higher-than-average margins. Merck was counting on the drug to be a core product, as it was already facing the loss of its top product, the cholesterol treatment Zocor, in 2006. The withdrawal of Vioxx also caused a significant amount of collateral damage. (An estimated $200 million of inventory at wholesalers will be returned, while $93 million of inventory on hand will be destroyed.) Furthermore, Merck could face a flood of Vioxx-related lawsuits. Whether or not these reap large settlements, the litigation would be a major distraction for management at a time when it's trying to revitalize its business. Merck's second-generation COX-2 inhibitor, Arcoxia, has been delayed, and sales prospects are now uncertain at best. The steep drop in Merck's stock price also makes it less attractive to use stock as a currency for transactions. No litigation reserves have been taken. The Vioxx implosion now makes Merck more reliant on its remaining core products. Cozaar/Hyzaar continues to do well, growing 15% year-to-date, and the franchise's market share remains steady in a growing angiotensin II receptor blocker market. Fosamax sales were up 13%, including the unfavorable effect of a wholesalers' advance buy-in of $10 million. Fosamax once-weekly had patent protection in the U.S. and Europe until 2007, but the European patent office has revoked it. Merck has appealed. Singulair grew 2%, but that included an unfavorable comparison because of a wholesaler buy-in of $120 million last year. Zocor sales were down 13%, in part because of an unfavorable comparison to last year because of a $110 million buy-in, but also because of continued generic inroads in international markets where Zocor has lost patent protection. Vytorin was approved by the FDA this past quarter, and net sales were $52 million. It's too early to determine how quick the sales ramp-up on Vytorin will be, but because the drug's earnings are shared by Merck and Schering-Plough, it would have to be rapid if Vytorin is to be a significant contributor to Merck's earnings and cash flows. Developments to watch: • Merck can expect more Vioxx headaches in the form of lawsuits. • Restocking its pipeline is even more critical now, given the loss of Vioxx and the uncertain potential of Arcoxia. Progress of three vaccines through Phase III clinical trials is critical. • It's important to watch for the continued health of Merck's remaining core franchises. • The CEO will retire in 2006, and this could augur a change in company strategy. The bottom line: Standard & Poor's plans to resolve the CreditWatch listing within the next three months (see BW Online, 11/1/04, "Merck on Watch for Debt Downgrade"). With so many strategic concerns and uncertainties, Standard & Poor's will have to determine whether Merck continues to warrant an AAA rating.
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